Islamic Liquidity Management The Malaysian Experience

1
Islamic Liquidity ManagementThe Malaysian
Experience

• Seminar on Islamic Finance Structure and
  Instruments
• 26 30 September 2011, Ankara, Turkey

2
Presentation outline

• Background of Islamic financial market in
  Malaysia
• Brief regulatory framework of Malaysian dual
  banking system
• Interrelationship of conventional and Islamic
  money market and liquidity
• Islamic liquidity management practices of BNM
• Objective of Islamic liquidity management
• Islamic liquidity management operation and
  instruments
• Challenges in developing appropriate
  Shariah-compliant instruments
• Challenges to the current and developing new
  instruments
• Addressing the challenges.

3
Malaysia dual banking systemcomprehensive
components of financial institutions to
facilitate effective intermediation process
Malaysian Financial System
Firewalls against commingling of funds
Conventional Banks
Islamic banks

• Separate
• Capital compliance
• Compliance to SRR single customer limits
• Compliance to liquidity framework
• Clearing accounts
• Membership code in RENTAS
• Cheque clearing system
• Statistical reports in Financial Inst.
  Statistical System on monthly basis

Islamic windows
Conventional Money Market
Islamic Money Market
Conventional Capital Market
Islamic Capital Market
Insurance Companies
Takaful Companies
Islamic windows of conventional banks

• For monetary operation purposes, two distinct
  pools of conventional Islamic liquidity are
  managed separately
• Monetary instruments applied are different in
  terms of concept structure but similar in terms
  of its effect on liquidity

4
Market structure Interbank Players the
Principle Dealers Network

• Dealing with Principal Dealers (PD) ensures
  efficiency
• Assists in the collection of bids/offers and
  confirmation of successful bids/offers
• Promotes a more active secondary trading in the
  money and capital markets.

Principal Dealers 12 CB (Con) 6 Islamic PDs
Submission of bids by interbank players
BNM
BNM Govt issued paper
PrincipalDealer
Bids
Fully Automated Tendering System
Money Tender
Bank Negara Malaysia
Bids
Standing Facility
Bilateral
Interbank players
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Financial Market Infrastructure
SECONDARY MARKET
SYSTEMS
PRIMARY MARKET
RENTAS
Investors/ Interbank Players
Issuers
Money Brokers Principal Dealers
ETP
FAST
IIMM Website
Investors/ Interbank Players
Investors/ Interbank Players
Market Players - 55 interbank players with
Islamic windows 17 full-fledged domestic Islamic
banks, and 3 foreign Islamic banks Intermediary
Channels - 6 money brokers as intermediaries and
18 principal dealers to provide two-way
quotations in secondary market Primary and
Secondary Market - fully automated system for
tendering (FAST), electronic trading platform
(ETP) provides near real-time prices, and market
information
Settlement Mechanism - real-time gross
settlement and custodian system for scripless
securities trading, reduces settlement
risks Legal framework - Islamic banking act,
takaful act, DFI, Anti Money laundering
act. Operational Regulatory framework -
central bank and securities commission issued
various guidelines e.g. repo, money broker,
principal dealer and product guideline, Accountin
g and tax system - adoption of generally accepted
accounting principles, easily understood tax
regime
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Monetary policy, liquidity management and role of
central bank

• Monetary policy aims at achieving sustainable
  growth in an environment of price stability
• The policy rate is Overnight Policy Rate,
  currently at 2.75 implemented in the
  conventional money market
• Objective of monetary operations
• meet the overnight operating target
• reinforce monetary policy intention, and
• manage liquidity in the interbank market.
• Monetary operations in both conventional and
  Islamic money markets focus on absorbing surplus
  liquidity, hence liquidity management operation.

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Malaysian conventional and Islamic money market

• Islamic Money Market
• Co-exists and operates in parallel with the
  conventional money market.
• Separate cash and securities clearing accounts
  under RENTAS (RTGS) platform.
• BNM conducts market operations via segregated
  pools of liquidity.
• Act as a short-term intermediary to provide a
  ready source of investment outlets based on
  Shariah principles.
• Integral to functioning of Islamic system
• Facility for funding and adjusting portfolios
  over the short term and
• Monetary policy transmission channel.

Transmission mechanism in the financial market
BNM
Government
Conventional Money Market
Islamic Money Market
Deposit/ Profit Rates
KLIBOR Lending Rates
Bonds/ Sukuk Equities Prices
Impact towards economy activities
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Monetary Operating Framework overnight policy
rate guided within a corridor
Overnight rate

• Overnight rate as the policy rate and also the
  operating target
• Operating band of 50 basis points to minimize
  extreme volatility
• Standing facility available at the ceiling and
  floor rate
• Overnight rate was chosen as the policy rate
• high controllability
• minimal expectation content
• Market determined rates at other tenors.

Lending facility
Ceiling rate (25 bps)
50 bps corridor minimise extreme volatility
Policy rate (3.00)
Floor rate (-25 bps)
Deposit facility
Time
Overnight rates to gravitate around policy rate
Liquidity is managed using money market tenders
and longer-term repo to ensure rates are not
persistently too low or too high
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In ensuring for a smooth and efficient monetary
policy transmission, the choice of instrument
used by BNM operations is crucial...

• Liquidity management operations
• influence liquidity via money market and repo
  tender to achieve operating target
• a price taker at all tenors of tenders (other
  than overnight), thereby allowing market-based
  pricing
• no direct intervention to set market rates
• also conduct overnight tender to mop up overnight
  excess liquidity.
• Choice of instruments
• degree of controllability on the monetary
  instrument
• degree of sensitivity or responsiveness of the
  monetary instrument and
• efficiency of the financial markets
• Banking institutions play an important role in
  monetary policy transmission as a conduit for
  channels of transmission.
• the direct interest rate effect KLIBOR, BLR and
  savings rate
• domestic asset prices including bond, stock
  market and real estate prices

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Monetary Instruments
Various instruments used to absorb liquidity in
monetary operations
Common Instruments to both Conventional and
Islamic Money Market
Outright Sales Purchases of Securities
Statutory Reserve Requirement
Conventional
Islamic
Repo Reverse Repo
Wadiah Acceptance
Commodity Murabahah Programme (CMP)
Up to 1-month
Money Market Borrowings
Foreign Currency Swaps
Bank Negara Monetary Notes (BNMNs)
Up to 3-months
Bank Negara Monetary Notes Islamic (BNMN-i)
Up to 6-months
Sukuk BNM Ijarah
Up to 1-year

• Frequency of operations
• Daily Money market borrowings, Wadiah
  Acceptance, Repo Reverse Repo, Commodity
  Murabaha Programme
• Twice a week BNMN BNMN-i

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Liquidity is managed twice daily.. term operation
in the morning, overnight operation at end of the
day
Standing Facility
BNMs Operational Intentions for Monetary Policy
Implementation
Further and final revision of liquidity forecast
overnight operations
Possible second round of dealing
0830
0930
1015
1045
1530
1630
1400
1600
1700
1730
1800
Close
Securities-driven repo ops (T1)
Forecast liquidity in the banking system for the
day
Submission of bid/offers via FAST
Revises liquidity forecast after tender
operations
Residual liquidity position is met by standby
facilities
Liquidity position may change due to exogenous
factors
Overnight operations via agent banks / overnight
tender
Publish liquidity forecast and details of
liquidity operations
FAST Fully Automated System for
Issuance/Tendering

• Liquidity forecast is published in FAST 4 times
  (9.30am, 10.45am, 3.30pm, and 4.00pm) throughout
  the day to reflect changes in factors that affect
  liquidity
• All monetary operations are conducted
  electronically via FAST

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Transparency of operation liquidity is
forecasted and operational intention is disclosed
to the market
Observe movement of funds

• Forecast aggregate liquidity.
• Movement of rates will be determined by
  availability of funds.

Decide on monetary tools

• Appropriate instruments used to structure the
  maturity profile, thereby influencing short term
  liquidity.

Disseminate information

• Allow market players to structure their liquidity
  profile.

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Six Islamic liquidity instrument introduced
to-date.. for both Islamic deposit and securities
instruments
Islamic liquidity Instrument Date Introduced Description of Instrument
Wadiah deposit acceptance Jan 2002 Cash funds placed on custody basis, with non-guaranteed returns on hibah (gift) basis.
Sukuk BNM Ijarah Feb- 2006 Sukuk issuance based on the Al-Ijarah or sale and lease back concept.
Bank Negara Monetary Note Islamic (BNMN-i) Dec-2006 Issued by Bank Negara Malaysia for managing liquidity in the Islamic financial market.
Commodity Murabahah deposit Feb-2007 CMP is a cash deposit product that utilises the Crude Palm Oil based contracts as the underlying assets.
BNMN-Murabahah Jul-2009 BNMN-Murabahah is essentially a trustee-receipt which utilises Crude Palm Oil (CPO) based contracts as the underlying assets.
BNMN-Istithmar Jun 2011 BNMN-Istithmar refers to portfolio investments into sale and lease-back of assets (Ijarah) and commodity mark-up sale transaction (Murabahah)

• Choice of instruments
• Diversification of the product base increase
  the number of instruments available.
• Liquidity management purposes (ALM) Islamic
  banks are biased towards liquid short-term
  instruments.
• Flexibility to meet market needs and requirement
  i.e. foreign banks operating in Malaysia.
• Shariah compliance issue consent and approval
  from Shariah Advisory Council.

Replaced by issuance of BNMN-Murabahah
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Liquidity facilities to support IFIs liquidity
management.. intraday credit facility and
standing facility
Intraday Credit Facility
Standing Facility

• A credit facility extended by BNM to RTGS member
  for a period of less than one business day.
• Members may utilize the intraday credit facility
  by pledging eligible securities in their
  collateral account.
• Eligible securities
• Securities issued by the government and central
  bank and any other specified instruments
• Other securities with minimum credit rating of A
  and above.
• Any intraday credit obtained from BNM will be
  paid immediately after the intraday credit
  cut-off time.
• There is no cost involved other than a very
  minimal administrative charge.

• A facility offered to all Islamic interbank
  institutions to
• Obtain overnight liquidity via Sell Buy-Back
  Agreement (SBBA) transaction using eligible
  collateral or
• Place overnight liquidity via wadiah deposit.
• Eligible collateral Islamic securities issued
  by government, central bank, quasi-government
  entities and other specified securities.
• Margin is applied on collateral and varies
  between different type of securities.
• Facility is available on a daily basis, on
  request by the individual institution from 4pm
  onwards.
• No limit to the funding amount, as long as there
  is sufficient underlying eligible collaterals.

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Current Islamic liquidity instruments.. its
challenges and implications
Deposit instrument
Securities instrument
Sukuk BNM Ijarah
WadiahAcceptance
Commodity Murabahah
Bank Negara Monetary Notes-i

• Return to depositors is in the form of hibah.
• Hibah is prerogative of custodian and it cannot
  be contractual, hence return is uncertain.
• It does not appeal for longer term placement for
  liquidity management as return, if any, is
  uncertain.

• Process is tedious and time-consuming series of
  trade transaction of underlying assets.
• Incur additional cost, relative to wadiah, in the
  form of commodity brokerage.
• Inefficient for use to manage short-term
  liquidity.

• Widely accepted and demanded by investors.
• Issuance is limited to the value Ijarah asset
  hence it is ineffective to manage massive
  liquidity.
• Due to insufficient issuance to satisfy demand,
  it leads to buy-and-hold strategy by investors
  causing lack of secondary trading of the
  instrument.

• Issuance not limited by issuers assets hence
  the flexibility in managing liquidity.
• Issuance incurs additional cost (commodity
  brokerage).

Challenge implication
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Going forward.. challenges in developing the
Islamic liquidity instruments

• Needs to have various type of instruments to
  cater for different issuers and investors'
  requirements and limitations
• Flexibility in addressing significant liquidity
  and fund flows
• Financial certainty within the confine of shariah
  parameters
• Wide acceptance of products by financial market
  institutions in view of diversity in shariah
  opinion
• Ensure effectiveness in managing market wide
  liquidity
• Efficient implementation process with regards to
  documentation
• Shariah understanding of the structure and
  business issue.
• Efficient infrastructure supporting the
  development of a new instrument
• Cost-effective supporting infrastructure for
  efficient transaction.
• Market understanding on new structures and
  sophistication of investors.
• Greater use of equity-based Islamic financial
  instrument, instead of debt-based.

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Addressing the challenges

• Conduct periodical consultation process with
  Islamic financial market participants
• Obtain feedbacks from market and address all the
  raised issues
• Have close and early collaboration with shariah
  and legal practitioners
• Understand the parameters and concerns of shariah
  and legal
• Have clear communication on business issues and
  needs
• Support market wide initiative infrastructure,
  documentation and education
• Give fullest support, including resources, to
  market players/association initiative
• Adopt culture of continuous improvement Kaizen

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Contact detailsAzizul Sabri AbdullahE-mail
asabri_at_bnm.gov.myWebsite www.bnm.gov.my /
iimm.bnm.gov.my / fast.bnm.gov.my
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Wadiah Yad Dhamanah (custody with guarantee)

• BNM absorbs liquidity by accepting deposits on a
  trust concept from Islamic financial
  institutions.
• BNM will safeguard and provide guarantee to the
  principle of deposits.
• Deposits maybe invested for return enhancement
  with permission from depositors.
• BNM is not obliged to give return to depositors
  Hibah (gift) can be given to depositors as a
  token of appreciation
• Widely acceptable by the universal scholars

2
Returns funds to Islamic banking institutions
upon maturity date
1
Hibah (if any)
Absorbs funds via Wadiah interbank acceptance
3
Financial Institutions
Fund flows
20
Commodity Murabahah Programme (cost plus)

• Cash deposit product based on a globally
  acceptable Islamic concept of murabahah.
• Based on sale and purchase transactions of
  non-ribawi assets.
• Cost and profit margin (mark-up) are made known
  and agreed by all parties involved.
• Settlement can be made either on a deferred lump
  sum or installment basis.

Commodity Broker B
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Bank A sells the commodities on behalf of BNM
Bank A purchases commodities from Broker
1
Bank A (Depositor)
6
2
3
Bank A sells commodities to BNM (at cost price)
Bank A credits the proceeds to BNM (placement)
BNM pays to Bank A on deferred basis (at mark up
price)
4
BNM appoints Bank A as an Agent to sell the
commodity (net off)
Fund flows at future date
Fund flows at spot date
Commodity flows
Ribawi items gold, silver, salt, date, wheat,
barley
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Sukuk Bank Negara Malaysia Ijarah (leasing)

• Sukuk issued based sale and lease-back
  transaction.
• Globally acceptable.
• BNM sells its Ijarah assets to SPV to obtain cash
  and absorb liquidity from market.
• SPV will issue sukuk to finance the purchase of
  assets and consequently lease the properties back
  to BNM.
• Lease rental paid by BNM to SPV will be passed to
  investors as return on sukuk.
• On maturity, BNM will buy the properties from
  SPV, which proceed will be used to redeem the
  sukuk from investors.

SPV pays for purchase of asset
1
4
At end of lease, SPV sells asset to BNM
Sell beneficial interest in asset
8
6
SPV leases the asset to BNM
Rental payment
5
Redemption upon maturity
9
2
Rental distribution to sukuk investors
Issuance of Sukuk Ijarah
Payment for sukuk
3
7
Asset flows
Fund flows
Sukuk beneficial ownership claims
Investors
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Sukuk Bank Negara Malaysia Murabahah

• Issued based on murababah concept.
• SPV issues sukuk to investors, which proceed is
  used to purchase commodity.
• Commodity are then sold to BNM on murabahah basis
  with deferred payment.
• BNM then sell the commodity purchased to another
  party to obtain cash and absorb liquidity from
  the market.
• At maturity, BNM will pay the purchase price,
  which will be used to redeem the sukuk.

Vendor A
Vendor B
SPV purchase commodity via agent
BNM sells commodity via agent
SPV pays for purchase of commodity
Commodity purchase price paid to BNM
4
2
3
1
SPV sells commodity to BNM
Payment for BNM Sukuk Murabahah
Issuance of BNM Sukuk Murabahah
Investors
BNM pays commodity purchase price on deffered
basis
Proceeds paid to Investors
5
5
Trustee
Fund flows at future date
Fund flows at spot date
Commodity flows
23
Sukuk Bank Negara Malaysia Istithmar (investment)
Issue Sukuk Murabahah
1

• BNM issues sukuk to investors, which proceed is
  used to purchase
• Ijarah asset, through purchase of asset
  certificate that represent ownership of asset
  trust which on issue date contain only Ijarah
  asset.
• Commodity which are sold at profit to BNM to be
  paid on deferred basis i.e. on maturity date of
  sukuk.
• Investors, through sukuk trustee, will leased the
  Ijarah to BNM, which rental will be paid and
  passed to investors as coupon payment.
• Upon maturity, BNM will buy back asset
  certificate from sukuk trustee, effectively
  redeeming the sukuk from investors.
• Asset certificate represent ownership of asset
  trust that upon maturity will contain Ijarah
  asset and commodity murabahah debt receivable.

BNM purchase asset certificate, and sukuk is
redeemed
8
Sell asset certificate
2
Investors
Sukuk Trustee
Rental payment
Asset is leased to BNM
3
4
Cash injection
Asset company sell commodities at markup price
to be paid on deferred
Asset Trustee
6
7
5
Asset trustee purchase commodity
BNM sells commodity via agent
Vendor B
Vendor A
Prior to sukuk issuance, BNM create an asset
trust and transfer its Ijarah properties into the
trust. An asset trustee is appointed to
administer the trust and accordingly it issues an
asset certificate to BNM to evidence the
ownership of the trust asset.
Fund flows at spot date
Fund flows at future date
Commodity flows
Asset flows
Sukuk movement
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Standing Facility Framework

• Instrument Sell Buyback Agreement (SBBA)
• Eligible collaterals Islamic securities issued
  by Malaysian Government, Bank Negara Malaysia
  (central bank), Khazanah, Cagamas
  (quasi-government entities) and other securities
  that may be specified by BNM from time to time.
• Application of margin between government,
  government-guaranteed and Bank Negara securities
  in one category and other securities.
• Access condition available to all interbank
  institutions on a daily basis, at their request
  from 4pm onwards.
• There is no limit to the amount an interbank
  institution may borrow or deposit under the
  standing facilities. However, under the lending
  facility, the amount borrowed is subject to
  sufficient underlying eligible collaterals.

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Sell and Buyback Agreement (SBBA)as a standing
facility

• The SBBA consist of two legs of transactions.
• In the first leg, the Islamic Financial
  Institution (IFI) with liquidity shortage offers
  to sell eligible Shariah compliant securities to
  BNM.
• Securities will cease to form part of the IFIs
  portfolio
• Subsequently the IFI make a unilateral promise
  (waad) to buy back the Islamic securities the
  next day (overnight) at an agreed price.
• treated as contingent liability
• Both contracts for each sale leg are independent
  of each other.
• The SBBA transactions enable IFI to acquire
  liquidity from BNM overnight.

1
2
IFI sells the Shariah-compliant securities to BNM
for spot cash in return
IFI promises to buyback the security on spot
payment the next day at an agreed price higher
than the 1st leg.
Islamic Financial Institutions IFI
Security flow
Cash flow
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Intraday Credit Facility

• Based on the concept of pledge (Al-Rahnu).
• BNM will provide a loan to the borrower based on
  the concept of benevolent loan (Qard hasan).
• IFI will pledge eligible securities as collateral
  for the funding received.
• If the IFI fails to pay off the loan, the
  securities will be transferred to the BNM and
  will be sold in the market.
• Under Qard, IFI is obliged to return only the
  exact amount of liquidity borrowed.
• IFI will be charged a custodian fee for BNM to
  hold the collateral pledged.

3
2
1
BNM as custodian to the security pledged, will
charge additional fee to the IFI
IFI returns the exact amount cash borrowed from
BNM
IFI pledges (Rahnu) eligible Shariah compliant
security owned in return for BNM lending (qard)
cash to the IFI
Financial Institutions
Collateral flow
Cash flow